Co-Movements Between Key Components Of Aggregate Productivity And Real Exchange Dynamics In Developing Countries

Abstract

The relationship between productivity growth and the real exchange rate has dominated the field of international economics for a long time. However, previous empirical studies do not focus on the nexus between real exchange rate and unraveling sources of productivity growth, i.e., technical change and several exhaustive measures of efficiency. In this paper, we investigate the relationship between the real exchange rate and key components of aggregate productivity for a sample of countries in four developing country regions. Our methodology proceeds in two stages. First, a non-parametric method is used to estimate the Hicks-Moorsteen total factor productivity (HMTFP) change, which is decomposed into technical change and different exhaustive measures of efficiency change. This methodology allows one to extract different exhaustive measures of efficiency change. Second, system-GMM models are used to explore the dynamics of the real exchange rate and different components of productivity while controlling for other exchange rate fundamentals and civil conflicts. The results for total factor productivity (TFP) and TFP efficiency indicates that the TFP has not changed much in the sample period. In addition, the average TFP efficiency has remained relatively low because only a few countries defined the best practice frontier while a majority of the countries operated below this frontier. In particular, Africa has lagged behind other regions in terms of TFP improvement. Our results also indicate that the main differences in TFP change are explained by differences in efficiency, an indication of disparities in the use of available technology across countries and regions. We also find that a positive change in technological innovation and its diffusion tend to appreciate the real exchange rate. These results are robust across different model specifications. Two key policy implications can be extrapolated from our results. First, our results show significant differences in the evolution of different components of TFP across regions; indications that policy targets to improve productivity growth across regions are unlikely to be uniform. Second, our results also show that policies that target specific drivers of productivity change have the potential to also influence the international competitiveness of a country through the real exchange rate-technological-efficiency change linkages.